Published by EH.NET (December 2007)

Alan Greenspan, The Age of Turbulence: Adventures in a New World. New York: Penguin, 2007. 531 pp. $35 (cloth), ISBN: 978-1594201318.

Reviewed for EH.NET by Alexander J. Field, Department of Economics, Santa Clara University.

Alan Greenspan’s new book is really two: the first, of most interest to a popular audience, describes his career in the private sector and subsequently as a government economist who served in one capacity or another as an advisor to six presidents. His up front observations of political leaders (he got along best with Gerald Ford and Bill Clinton) are of considerable interest, and his autobiography provides an interesting and valuable overview of U.S. economic growth from a macro perspective since the Second World War. The second part of the book is a broader discussion of recent world economic history and prospects, with detailed discussions of China, Russia, India, and Latin America (but virtually nothing on Africa), along with chapters offering his perspective on major policy questions facing the United States.

Political memoirs are not usually good grist for the economic historian’s mill, but Greenspan is sui generis, and the book is well worth reading. Economists will have the advantage over the general reader of being able to follow without difficulty the discussion of policy issues, such as those surrounding the causes and challenges created by current account deficits, and identify areas of possible weakness in the analysis. You are also sure to learn several arcane economic details about which you were previously innocent, such as the role of the Henry Hub in natural gas pricing, and you will get fresh perspectives on many aspects of economic policy and recent macroeconomic history.

Although central bankers have no direct responsibility for fiscal policy, the greatest blight on Greenspan’s record is surely his political support for tax cuts in the early 1980s and early 2000s, and the large peacetime deficits they created. Under President Reagan, when David Stockman and Don Regan expressed doubts about the wisdom of pushing forward with tax reductions in advance of commitments for spending restraint, Greenspan joined in the advice of the economics advisory board chaired by George Schultz, telling the President that “under no circumstances should you delay the tax cut” (92). As an influential chairman of the Fed under our current President he bears even more responsibility for greenlighting the 2001 cuts. Counseled by former Treasury Secretary Robert Rubin and Senator Kent Conrad that his testimony would be perceived as providing cover for expanded deficits, Greenspan went ahead anyway, claiming he couldn’t control how his testimony would be perceived (220). He now admits that Rubin and Conrad were right. Philosophically, Greenspan can claim consistency in being against peacetime budget blowouts but it is clear in retrospect that he facilitated massive deficit spending under Reagan and George W. Bush, while preaching fiscal conservatism to Clinton. While Greenspan rightly bemoans the lack of spending restraint, he does not fully accept responsibility for his role in facilitating these outcomes.

Greenspan also, in my view, is far too sanguine about the current account deficit and our increased international indebtedness. Chapter 18, which treats these matters, will be impenetrable to the general reader and tough going even for some economists. His command of the issues and history here is weaker than in chapters that focus on purely domestic analysis.

Throughout most of the twentieth century (and in contrast with the nineteenth), the United States ran current account surpluses. This has been the standard pattern for an advanced developed country. As did Britain in the nineteenth century, the U.S. exported capital, using part of its domestic saving to fuel development outside of the country and in the process building up a large stock of net overseas international assets. This apple cart was overturned in the first half of the 1980s by President Reagan’s unprecedented peacetime federal government deficits, the result of a collision between supply side tax cuts that implausibly promised to pay for themselves, the commitment to a rise in defense spending including Star Wars and a six hundred ship Navy, and an unwillingness to reduce entitlement spending or corporate welfare. These deficits pushed up real U.S. interest rates (nominal rates were falling but inflation was falling faster in part as the result of Chairman Volcker’s monetary stringency). Within the context of a flexible exchange rate regime, the high real interest rates led to an inflow of funds from outside of the country, generating a capital account surplus and an appreciated dollar that in turn produced the deterioration of the current account, reflecting the real transfer of resources from the rest of the world to the U.S.

Greenspan, however, inexplicably begins his current account narrative in 1991. It is true that the deficit had again become quite low in that year, but this was principally due to the U.S. recession. Starting the narrative in that year conveniently or inadvertently ignores the role of fiscal policies in the 1980s, which by the middle of the decade had already resulted in the effective liquidation (on net) of the U.S. overseas economic empire. It is true of course that the current account deficit persisted and widened, even in 1998-2001, when the federal budget was in surplus, so there were and are other forces involved, particularly capital flight associated with the transfer of Hong Kong to Communist China, and political instability elsewhere in the world.

Thus, it is clearly not just international crowding out that led to the rise in U.S. international indebtedness over the past quarter century. That mechanism ? dominant in the 1980s ? “pulled” funds into the U.S. by generating attractive risk adjusted returns. But it is also clearly the case that a rise in global saving has, particularly in the last decade, “pushed” funds into U.S. asset markets. The consequence is that current account deficits were associated with high real interest rates in the 1980s but relatively low ones in the 2000s. Greenspan is at his strongest in articulating the underpinnings of the global saving glut hypothesis that both he and Ben Bernanke have championed.

The argument is that globalization has brought rapid economic growth to parts of the developing world, and that these countries lack either well developed social safety nets or an entrenched consumer culture, so that their saving flows have risen. In the presence of rising incomes and strong motives for precautionary saving, and in the absence of an established consumer culture or attractive and accessible domestic financial assets or direct investment opportunities, these flows have ultimately been absorbed by sales of U.S. assets. There is of course considerable merit to this analysis, but it is still remarkable that although Greenspan discusses at length the role of household dissaving in the U.S., he avoids discussing the role of government dissaving, which reemerged with renewed force under our current president.

In a humorous vein Greenspan recalls that he can think of many times he was criticized for raising interest rates but never once for lowering them: “During my eighteen-and-a -half year tenure I cannot remember many calls from presidents or Capitol Hill to raise interest rates. In fact I believe there was none” (478). But in terms of post-mortems on his conduct of monetary policy, he seems to have this exactly backwards. The persistent criticism one hears today is that his policy was too easy, first in the 1990s, and then again in the 2000s. Greenspan is faulted, at least in retrospect, for enabling, with cheap credit, first a stock market and subsequently a real estate boom. The force of the indictment here is less straightforward, however. It is, as Greenspan suggests, and as Bernanke has reaffirmed, not obvious that the central bank should view control of asset prices as part of its mandate. It is in any event not an easy matter to deflate an asset price bubble without significantly damaging the real economy. Others, however, believe these issues can and should be addressed by central banks, if not through interest rate policy then through bank regulation and supervision.

Greenspan was conflicted over the issue. He spends considerable time discussing his “irrational exuberance” remarks, and how he subsequently got religion about the delayed role of IT investment in advancing productivity growth and possibly justifying high stock market valuations. In contrast, there is surprisingly little discussion of the recent real estate boom and crash, and little attempt to justify his apparent lack of concern about declining lending standards, or the degree to which easy money may have fueled the boom. It remains to be seen how well the U.S. economy will weather the collapse of housing investment, the drop in housing prices, the rise in foreclosure rates, and the threat to financial institutions and possible systemic risk this has generated.

Another tension in his analysis involves the treatment of the challenges posed to Social Security by the impending retirement of baby boomers. Much of the decline in the ratio of those paying into and those drawing from the system (it currently stands at about 3:2) has already taken place, but a further decline to rough parity is still ahead. So the challenge is how to support a growing nonworking population without levying payroll taxes so high that the living standards of those remaining in the labor force fall. The solution, all agree, is to raise national saving (private sector saving plus the government surplus) and thus facilitate private sector capital deepening that will leave the working population with a higher per capita stock of capital (and higher output per hour) in the future, so that even taxed heavily to support baby boom retirees, their incomes can still rise. The point of the Greenspan commission reforms (1983) was to achieve this, principally by raising payroll taxes.

But the boost to national saving that might otherwise have ensued was undone by the Reagan and subsequent Bush tax cuts, so the net effect, since these cuts were skewed toward the wealthy, has been simply to shift the overall tax burden toward lower paid workers. If the government bonds in the Social Security trust fund are backed by the full faith and credit of the United States (and if they are not, all holders of U.S. paper ought to be concerned, because we will be undoing what Hamilton worked so hard to achieve in the early national period), then we will in the future still need to cut into the living standards of those working by raising enough general tax revenues to service the debt.

Although, over the past quarter century, and ignoring the last few years of the twentieth century, there has been little long term boost to national saving from fiscal policy, there is also little evidence that budget deficits adversely affected the accumulation of domestic physical capital. That is because we tapped into massive flows of foreign saving, which enabled us to finance both government deficits and increases in gross private domestic investment.

Our systemic needs in this area, particularly its nonresidential component, have, nevertheless, grown remarkably slowly. Investment in such capital increased hardly at all between 2000 and 2005. This was not due to credit stringency, since both long and short term interest rates were at historically low levels. Given the choice, private sector decision makers flowed credit instead to housing, investment in which increased 70 percent (nominal) over the same period.

What accounts for the low increase in the manifested demand for nonresidential fixed capital? Greenspan suggests that part of the explanation lies in capital saving technical change: “Thin fiber optic cable, for example, has replaced huge tonnages of copper wire. New architectural, engineering and materials technologies have enabled the construction of buildings enclosing the same space with far less physical material than was required fifty or one hundred years ago ” (492). A related manifestation of these trends, he notes, is that the physical weight (in kilograms) of U.S. GDP is currently about what it was after the Second World War, although its value is much higher.

These trends mean that even if in the future we are successful in raising national saving, the typical pattern of capital deepening ? rises in the ratio of the nonresidential fixed capital stock to labor input– may not be as operative as in the past. Rising saving flows may, as they have recently, augment living standards by raising the housing stock, which increases the flow of real housing services. If that option is no longer attractive, they will by default finance accumulation (or reduced decumulation) of foreign assets or, if we take a somewhat broader definition of saving, investment in government infrastructure or R&D which is complementary to private sector capital.

Given the record since 2000, the challenge for the U.S. standard of living looking ahead is evidently not that we have accumulated too little private sector physical capital. It might be that we have invested inadequately in government infrastructure and R&D, although the current political dynamics of earmarks and pork barrel spending do not suggest such funds are being well allocated from the standpoint of economic growth. It’s possible that we have left money on the table by not adequately resourcing education (human capital formation). What is certain, however, is that we have liquidated (on net) our overseas economic empire and instead of receiving net payments from the rest of the world we can now count on making them. It is true that absent the government deficits, we would most likely still have had capital account surpluses, particularly in the last fifteen years, but they would not have been as large, and U.S. indebtedness to the rest of the world would not have grown as rapidly.

If our net international investment income has become only modestly negative it is only because the gross U.S. holdings of overseas assets are heavily skewed toward direct rather than portfolio investment (and we earn a relatively high rate of return on the former), whereas foreign holdings of U.S. assets are heavily weighted toward portfolio investments, particularly safe but low yielding Treasuries. Still, with U.S. net international indebtedness in the range of $2.5 trillion, and with current account deficits of 6 percent of GDP a year adding to this, the mathematics are inexorable: the burden of servicing this debt will adversely affect the U.S. standard of living in the future just as much as would have a slower rate of accumulation of domestic fixed capital, although through a different mechanism.

Greenspan’s neglect of the contribution of government dissaving to this outcome is a weakness of this book, just as his role in facilitating such dissaving is a weakness in his policy making record. His calls to solve the entitlement problem by increasing national saving sound somewhat hollow in light of his record over the quarter century (with the exception of the Clinton years) in contributing as a political actor to its reduction.

One of the most interesting aspects of the book from the standpoint of an economic historian or a macroeconomist is his treatment of globalization as a positive supply shock that facilitated the world wide disinflation that began in the 1980s. Perhaps surprisingly, he does not credit central bank monetary policy for this, or at least does not credit it very much (391). He suggests that growth with low inflation has been too easy to achieve. This perhaps takes too much from the accomplishments of his predecessor, Paul Volcker, who helped pave the way for the single digit inflation of the last quarter century by slowing the growth of U.S. monetary aggregates, in the process producing the most serious recession in the country since the Great Depression (Greenspan didn’t take over until 1987). Greenspan notes that aside from Venezuela, Iran, Argentina, and Zimbabwe, the world today is remarkably free of inflation. But how much of this is due to central bank learning and how much to the positive supply shock of globalization, which has brought hundreds of millions of people into contact with the world economy, remains to be sorted out.

Greenspan is not a card carrying economic historian, but he has a serious interest in it, and this is evident throughout the book. The acknowledgments indicate that along with Bill Clinton, Steven Breyer, and Bob Rubin, Greenspan interviewed Paul David, who is credited, through his work on the diffusion of electric power, with helping Greenspan buy in to the idea that IT investments might impact productivity growth with a substantial delay. Thus, if the speed limit for the U.S. economy had as a consequence gone up, one could have faster monetary growth without necessarily risking inflation. Still, in terms of supply shocks that might have facilitated low inflation growth, there is less discussion of the impact of IT on total factor productivity growth than there was in Greenspan’s speeches in the late 1990s, and more emphasis on the role of globalization as a world wide positive supply shock. He sees this ultimately as a one time transition, and in his forecast for the future, Greenspan anticipates some upswing in inflationary pressures, which will raise nominal interest rates from their current levels.

Much of his policy discussion is sensible and relatively nonideological. For example, he appears to endorse, with some reluctance, a $3 a gallon tax on gasoline (461) and he supported the requirement that stock options be expensed, in spite of the entreaties of people like Intel’s Craig Barrett. He repeatedly emphasizes his concern for worsening economic inequality and the threat this may pose to the market systems that generate economic growth. He favors some form of private accounts for Social Security, but spends little time trying to justify the position or support the President’s failed initiative in this area. He correctly notes that the problems of Social Security are relatively small and manageable in comparison with those associated with Medicare and Medicaid. And, though a libertarian and a onetime acolyte of Ayn Rand, he acknowledges that there can be a positive role for some government regulation and infrastructure, describing, for example, his realization that the Fedwire system has advantages over what a private sector payment system could provide (374).

Greenspan has clearly been a creature of politics as well as economics. That said, what emerges in this book is a picture of the author as a man of great intellectual curiosity about how the economy works, a curiosity he has sustained for over half a century.

Alex Field is the Michel and Mary Orradre Professor of Economics at Santa Clara University and Executive Director, Economic History Association, His most recent publications are “Beyond Foraging: Behavioral Science and the Future of Institutional Economics” Journal of Institutional Economics 3 (December 2007): 265-91 and “The Impact of the Second World War on U.S. Productivity Growth.” Economic History Review 61 (February 2008).